HSBC: Everything Is Awesome...For Now
Aggregate US Corporate High-Yield (HY) leverage metrics are higher today than they were in 2008 but this is OK because interest coverage remains stable according to HSBC's Edward Marrinan. Which means his most pessimistic view on default levels will likely not play out which leads him to concluded corporate defaults should be nearing their highest peak since 2009 before reversing. For this recent cycle the default rate peaked at 5.6% in January.
With gracious thanksgiving to low rates, the debt that was unmanageable in 2008 is now manageable as firms issue new debt at low rates to generate cash flows and service debt. Basically, rates can not increase because then the music stops but worry not because sure enough, rates are expected to rise twice, maybe three times in 2017 depending on who you ask or what notes and news you read.
Our two cents: Worry.
Financial professionals strive to create an aura of "we know what we're doing". That is their job.
As Marrinan puts it, the new issuance raised at low interest rates is supporting cash flows and "improving [business'] ability to service much higher debt burdens."
Marrinan notes that barring a financial or exogenous shock (such as a collapse in commodity prices), the "compromised state of credit fundamentals suggests that the HY universe’s margin for error is significantly reduced."
Certainly we can trust the money masters. We have nothing to worry about, they're professionals.
Rest assured though that the following risks to Marrinan's assumption that corporate defaults will decline won't happen because the money masters are, well, professionals.
"First, if the US economy were to fall into recession, the pace and volume of corporate defaults would almost certainly rise." Marrinan cites the Atlanta Fed GDP-based recession indicator..the indicator that proves right when it's too late since it peaks to 100% months into a recession.
"Second, with developed market central banks deploying unconventional monetary policy, a policy misstep could destabilize the financial markets and disrupt the currently favourable conditions for most borrowers."
Perhaps the unconventional policy is the hacked SWIFT system that still remains an open sieve for hackers to try to steal money from. But once again, trust the money masters, they're professionals.
"Third, given that the USD HY index remains heavily concentrated in the oil & gas and metals & mining sectors, any sharp declines in the price of underlying commodities would likely exacerbate the pressures on these sectors’ credit profiles."
In conclusion, so long as nothing happens, like a Black Swan, everything will be fine and as we all know, we can see Black Swans coming, right?
Worst case, the FOMC could adopt the OPEC method of control and just talk the market back up as the algorithms try to front run order flow off headlines reiterating the empty commentary as we have witnessed in the oil complex thanks to some OPEC/Non-OPEC talking heads.
Trust the money masters, they're professionals. Everything will be fine until it isn't.
But what! There is more!
If you call now we'll throw in a compromised covenant quality metric. As Marrinan notes "covenant quality remains compromised".
All in all, the corporate default rate should peak in 2017 according to HSBC's Marrinan unless something, anything, happens.
Grab the popcorn.
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